Buddies, Colleagues and, Prosecutors Allege, Inside Traders

By

Chad Bray And

Reed Albergotti

Updated Nov. 19, 2012 10:39 p.m. ET

A network of high-school buddies and former co-workers often talked on the phone about the "Fat Man," and giving each other their "vacation photos," but federal prosecutors say those were code words used to disguise an insider-trading ring that lasted five years.

The group, which included three health-care executives, a chiropractor and the owner of a spa-supply company called Yeah Baby, allegedly made more than $1.7 million by passing on secret information about mergers and acquisitions and earnings announcements of at least seven pharmaceutical companies, according to prosecutors and the Securities and Exchange Commission.

According to a criminal complaint filed in Newark, N.J., by U.S. Attorney
Paul Fishman,
the men allegedly used codes or incorporated secret information in legitimate social conversations at basketball games, dinner with friends or morning jogs. In one case, one member of the alleged scheme sent an unindicted co-conspirator the number of a pay phone outside a Virginia K-Mart store to communicate. They referred to at least one financial deal as the "Fat Man," and used phrases like "fat man has a friend" and "the fat man walks alone" to update one another on the status of the deals, according to the complaint. The words "I have some vacation pictures for you" were allegedly used to refer to cash payments made to tippers in amounts ranging from $500 to $10,000 at a time.

And to avoid leaving a financial trail, those who allegedly traded on the information paid the tippers in envelopes of cash. In one instance in March 2010,
John Lazorchak
—who law-enforcement authorities say was one of the main sources of inside information—sent back a check to a tippee and insisted on cash payment instead.

The alleged insider-trading ring began in fall 2007 shortly after Mr. Lazorchak moved to New Jersey and joined
Celgene
Corp.
, a biopharmaceutical company, the SEC said. He was dismissed Monday, the company said.

The alleged scheme included high-school friends of Mr. Lazorchak, his former boss and members of his former boss's wine-making club. Those charged are: Mr. Lazorchak, who was the director of financial reporting at Celgene;
Mark Cupo,
Mr. Lazorchak's former boss at
Sanofi-Aventis
,
where he was director accounting and reporting;
Michael Castelli,
Mr. Cupo's friend from his wine-making club;
Michael Pendolino,
Mr. Lazorchak's high-school friend who now works as a chiropractor in New Hampshire;
Mark Foldy,
a former marketing executive at
Stryker
Corp.
; and Yeah Baby owner Lawrence Grum who was introduced to Mr. Cupo by Mr. Castell.

Mr. Lazorchak, 42 years old, attended Colonia High School in Colonia, N.J., along with Messrs. Pendolino, 43, and Foldy, 42, according to the criminal complaint. Messrs. Castelli, 48, and Grum, 48, were classmates at another unnamed high school, according to the SEC.

The SEC, which filed related civil charges in U.S. District Court in New Jersey, said the trading was carefully orchestrated in order to avoid detection by using middlemen to avoid a direct connection by the insiders and those who traded.

Those who carried out the trading allegedly tried to hide their activity by compiling binders of research to serve as a false basis for their trading and actively trading in some securities to create a pattern of long-standing positions in a stock, prosecutors said.

A lawyer for Mr. Lazorchak declined to comment.

Jonathan Marks, a lawyer for Mr. Foldy, said his client was a "very impressive and upstanding guy who it appears exercised incredibly poor judgment." Stryker said Mr. Foldy is no longer employed by the firm and declined further comment.

Lawyers for Messrs. Cupo. Grum, Castelli, and Pendolinio didn't return phone calls seeking comment Monday. All of the defendants surrendered to the Federal Bureau of Investigation and appeared in federal court in Newark; they entered no plea.

FBI spokeswoman Barbara Woodruff said the investigation used "proactive, sophisticated techniques" to uncover the alleged ring. "This multipronged approach to securities fraud investigations like this has proven to be very successful," she said.

As recently as two months ago, one of the alleged members of the scheme was confident that investigators would fall short of cracking the case. "If they ever come to me, I know what I'm doing," Mr. Grum told another person involved in the alleged scheme who had agreed to cooperate with criminal investigators, according to the complaint. The person wasn't identified in the complaint.

In the recorded conversation, Mr. Grum said: "Search my phone records, search anything—I know nobody at that company," he said. "There's no link,' he said. "And that's what they do to link up everybody. That's how they triangulate," he said, according to the complaint.

Mr. Grum explained that he had maintained a notebook for five years that included research that could be used to justify the alleged trades.

Ultimately, Mr. Grum said the SEC wouldn't come after them. "The SEC's got to pick their battle because they have a limited number of people and huge numbers of investors to go after," he said.

"This is yet another case where wrongdoers believed they could outsmart investigators by creating an elaborate smokescreen to hide their insider trading," said Daniel M. Hawke, chief of the SEC Enforcement Division's Market Abuse unit.

Mr. Hawke said computer technology enabled the enforcement staff to uncover the alleged trading ring. The software helped them to make connections among traders through their use of middlemen, cash payments and code words. "The techniques that we're using now are helping us to overcome those obstacles," said Mr. Hawke.

As those involved conducted more trades, and more people were brought into the circle, the SEC's staff narrowed down the list of culprits to a small group of friends connected by a common high school, professional relationships and social groups.

The alleged scheme nearly fell apart in April 2008 when the Financial Industry Regulatory Authority began an inquiry into suspicious trading surrounding Celgene's acquisition of Pharmion Corp. in 2007, prosecutors said. When shown a list of individuals who made suspicious trades, Mr. Lazorchak claimed he didn't know anyone listed, even though the list included Mr. Foldy and another high-school friend, prosecutors said.

"The actions taken by this employee violate Celgene's values, guiding principles and formal policies," the company said on Monday.

According to the SEC complaint, at least seven people, whom the agency didn't identify, allegedly received confidential information during the scheme. Other alleged members of the conspiracy described in the criminal complaint but not charged on Monday included a reporter/editor at a financial news website; a member of a New York hedge fund's risk assessment department and a government contractor who lived in Virginia.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.